Bitcoins: A Real Currency or a Chimera?

According to the shrill emails received and the rants by Max Keiser on RT’s economic program on DSTV, the solution to currency crises is the adoption of a virtual or a cryptocurrency – call it what you will – such as Bitcoin. Seemingly immune from government and bankers manipulation, they are a secure method to bypass government control. Will this “currency” ultimately supplant traditional currencies or will it be a chimera? Won’t the criminal element combined with human greed, folly and venality ultimately prove its downfall?

According to its adherents, Bitcoin is an innovative payment network and a new kind of money. Bitcoin uses peer-to-peer technology to operate with no central authority or banks; managing transactions and the issuing of Bitcoins is carried out collectively by the network.

To claim that I am too technologically challenged to understand the concept how new Bitcoins can be “mined” is a gross understatement. Clearly that is the reason why the gestation period of this blog has been over a year. What I fail, in my lack of wisdom to understand, is how a value can attach to a bit on the internet or in the cloud?

Originally the physical value of the coins – usually gold and sometimes silver – represented its value. This situation resulted in a stable value. Naturally unscrupulous governments or traders would “devalue” the currency by reducing the quantity of metals used in its production. Such underhand tactics could easily be spotted.

Just as crucially it was not only the quantity of metal in the coins which created its value but the total quantity of that precious metal available. This phenomena the Spanish were to discover with their uncovering huge quantities of gold and silver in South America. Instead of the Spanish government becoming rich beyond belief, the value of the coins in circulation was devalued. This should represent a cautionary tale to all those who proclaim a return to the gold standard as being a panacea.

Vector of a sign for web of bitcoin accepted here

Even when a physical object represents the value of the currency, this is not a store of value under all circumstances.

Paper notes were then issued to represent a certain quantity of a physical commodity held in storage by a Central Bank. For centuries governments maintained the fiction that the notes in circulation were backed by physical goods usually being gold or silver. From a position of parity between the value of the notes and the value of the physical items, this was gradually eroded until the physical goods ultimately represented a fraction of the notes issued.

Largely due to the onerous costs of war, the British were the first major power to ditch his falsehood as it peremptorily left the Gold Standard.

Bitcoin

The value of a currency was now based on the value of a country’s GDP. Printing additional money would never add to a country’s worth. Instead it would result in delayed inflation such that the total value of the money supply would again become equivalent to the country’s GDP.

Many countries have tested this assumption with equally disastrous results. The first was Germany during the early 1930s. Recently Zimbabwe attempted to print notes faster than the rate of inflation. In both cases their currencies became worthless. Neither succeeded nor in fact has any country succeeded. The amorphous market will automatically correct for an oversupply of money by devaluing the currency through inflation.

The ruinous decline in the value of the currency occurred because Central Banks at the behest of governments printed money in the mistaken belief that they could generate wealth. Even the most intelligent governments are bedazzled by the prospect of obtaining something for nothing; the panacea to all their problems.

The world has recently witnessed the printing of money under the beguiling term of Quantitative Easing. This phenomenon has added grist to the mill for believers in cryptocurrencies. Their concern – quite rightly so – is that governments are wilfully debasing the currency. On this matter they have passed withering judgement of late. The fact that governments can arbitrarily print money, thereby devaluing one’s savings means that the value of their savings is open to abuse

What role do currencies play in our lives? Most people mistakenly conflate money and medium of exchange. Whilst this is true, Economists also define money as a store of value and a unit of account.

According to the Economist in January 2015 – when I commenced writing this blog – Bitcoins possess three useful qualities in a currency viz “they are hard to earn, limited in supply and easy to verify” Of the three characteristics of Bitcoins, it serves best as a medium of exchange. Like all commodities whether corporeal or incorporeal, the value of a Bitcoin is subject to normal market forces. For the crypo-fundamentalists, it was an article of faith the unlike normal currencies, Bitcoins would be a stable store of value. They paid handsomely in esteem for this foolish supposition when over the past year, the value of Bitcoins has become hugely volatile. There was something profoundly moving when an adherent is proved to be so fallible.

Lastly, Bitcoins have not become the Unit of Account. Quite rightly so. The great immovable force will remain governments. As soon as any governments abdicate control of their currency to another authority such as Greece to the ECB and Zimbabwe to the USD, their ability to print money is eliminated. Their “wiggle” room at budget time is removed. Instead of making their economic programmes affordable by devaluing their currency through inflation, their funding will become ostensible by means of overt taxes. This is unpalatable to most government as they prefer the sleight of hand con-trick.

Similarly, governments will resist by forbidding the use of Bitcoins as the Unit of Account. This will serve two purposes viz the prevention of money laundering and the collection of taxes on all transactions.

How does one trade Bitcoins?

Bitcoins can be bought and sold both on- and offline. Participants in online exchanges offer Bitcoin buy and sell bids. Using an online exchange to obtain Bitcoins entails some risk. According to a study published in April 2013, 45% of exchanges fail and take clients’ Bitcoins with them. To allay custimers fears, Exchanges have since implemented measures to provide proof of reserves in an effort to convey transparency to users. Offline, Bitcoins may be purchased directly from an individual or at a Bitcoin ATM. None are currently available in South Africa.

How are Bitcoins created?

For good reason most people including myself are puzzled about how they are created. The literature alludes to the fact that they are “mined.” I assume that this is in the figurative sense. The confusion is even more pervasive that this. Bitcoins are created as a reward for confirming Bitcoin transactions. These “coins” are no more than bits in a computer with the details of the Bitcoins movements being recorded in a Blockchain. Suffice to say that the crowning mystery is that ultimate controllers and founders of Bitcoins are an enigma.

By extolling the virtues of anonymity of the Users of Bitcoins, they are potentially plunging us headlong into a crypto- black hole. Without the external control and governance of a regulatory body with the golden age of crypto-currencies become the graveyard of one’s wealth and pensions.

The final reason that is advanced for the adoption of Bitcoins is that Banks charge users a commission for providing that service. Isn’t the fact that Bitcoin Miners are remunerated for their efforts of confirming transactions in the form of Bitcoins implicitly mean that there is a “charge” however it is sanitised. On which central computer will these transactions be stored? This fact alone should provide pause for the proponents of this currency. As currently envisaged, all transactions will be stored in perpetuity. By simple extrapolation, this implies billions of transactions daily.

What is the true value of Bitcoins

Financial journalists and analysts, economists, and investors have attempted to predict the possible future value of Bitcoin. From the many apocalyptic commenters is an economist John Quigginwho stated in 2013 that “bitcoins will attain their true value of zero sooner or later, but it is impossible to say when”

A Final Word

Are Bitcoins a Ponzi Scheme or is it merely collective delusion. In my book, Bitcoins will only pass muster when they are transparent and the normal rules of governance apply to them. Perhaps it is a Ponzi Scheme writ large. One of Bitcoins original raison d’etre was its anonymity but without openness will it ever be a resounding success?